Microsoft suffered from the biggest single day decline since December 2000 as its share slided more than 11% yesterday. This is equivalent of a loss of $32B in a single day! The hot issue now is whether this company is a buy or not.
Prof. B. Greenwald, from Columbia Business School, has said in his lecture before that big company like Microsoft has hundreds of analysts following it. Therefore, it is crucial to know why you think you are right in comparison to the army of analysts.
Let me do some simple analysis on Microsoft:
Step 1: FCF/EV yield vs. Treasury yield
Enterprise Value (EV) = $232B
Free Cash Flow (FCF) = $14.5B
FCF/EV yield = 6.25%
Treasury yield (30 years) = 5.17%
Microsoft looks like a better deal than treasury yield.
Step 2: Insider holdings
I have mentioned about superior return by investing in founder-CEO companies. Investing in companies that have significant insiders holding is one of the great ways to achieve superior return.
Steve Ballmer and Bill Gates have holdings over 10% of the Microsoft, and they have significant passion for this company. Without doubt, they will work extremely hard to expand Microsoft Empire.
To read my previous comment on insiders holding, please visit: http://dahhuilaudavid.blogspot.com/2006/04/superior-stock-return-by-having.html
Step 3: Is Microsoft a Good Company?
Profit Margin (ttm): 31.57%
Operating Margin (ttm): 40.92%
Return on Assets (ttm): 16.09%
Return on Equity (ttm): 28.56%
By looking at these simple indicators, Microsoft is not only a good company, but a superior one.
Step 4: Does Microsoft management shareholders-orientated?
Microsoft has been buying its own shares aggressively; purchasing up to $13.88B, which is more than its income of $13B. On top of that, Microsoft has paid up to $3.44B of dividend. I view this move as a very favorable management of Microsoft. Buying back shares and paying dividend are important steps to enrich shareholders, as long as it doesn’t restrict its financial ability to expand and improve its service.
Step 5: Do you understand its Business?
Almost everyone uses Microsoft products, and it is a simple company to understand. Microsoft Corporation engages in the development, manufacture, license, and support of software products for various computing devices worldwide. As Microsoft is famously known, I’m not going to elaborate further on its business.
Step 6: Does Microsoft have a Moat?
Warren Buffett emphasizes “moat” seriously. He would only invest in companies with “castle-like moat with alligators swimming around it”. At the moment, Microsoft does have significant moat with its dominance in PCs operating systems (over 90% of operating systems use Microsoft products). However, it is hard to tell what will happen in 10 years time. That is why Warren Buffett has not invested in a significant way in Microsoft despite Bill Gates is his good buddy.
Step 7: Does any superinvestor invest in Microsoft?
There are some superinvestors interested in Microsoft, e.g. Charles de Vaulx (2.79% of assets), George Soros (2.52% of assets), Brian Rogers (1.33% of assets) and others. However, I have not found any superinvestors invest in a significant way in Microsoft.
Step 8: What are the potential risks in buying Microsoft?
As I discussed above, I am not sure how will Microsoft’s moat evolves in 10 years time. In this fast changing world, many things could happen, and technology and software may become obsolete really fast. If Microsoft failed to maintain its superior software, its moat will evaporate.
As importantly, size matters in determining superior stock return. Microsoft has one of the largest capitalizations in the world. The bigger the company, the lower the return. However, John Chew, an independent analyst wrote……
“Intel, MSFT, Coke, CISCO are all behmouths--they became huge through their dominance, so their size will limit returns vs. a smaller cap company.
However, what you give up in returns you may pick up in safety through their consistent slower growth IF the management knows they are over capitalized and return cash to shareholders through buybacks and dividends.
MSFT is essentially a utility company--they control 95% of the operating systems market and they earn 100%+ returns on tangible capital, the problem is what do they do with the cash? Let it sit on the balance sheet, deworseify, or give it back to shareholders. If mgt. returns cash to shareholders then buying at a 30% discount to IV with IV growing through 4% to 6% organic growth and 4% to 6% share buybacks or dividend yield is not bad given that it probably will be hard for the market to average much above 6% over the next few years.”
Conclusion:
Microsoft is a buy for me at current price of $24.15. I’m going to end my discussion here by quoting Warren Buffett….
“Buy companies with strong histories of profitability and with a dominant business franchise.”
Happy investing,
Dah Hui Lau (David)
dahhuilaudavid@gmail.com
To visit my archive: http://dahhuilaudavid.blogspot.com/2005/11/archive-of-dah-hui-laus-blog.html
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